STEELE, Chief Justice:
This is an appeal from the Court of Chancery's dismissal of a class action complaint challenging the merger of a limited partnership with its general partner's controller. The plaintiff limited partner's complaint alleges that the general partner, its controller, and its directors took actions during and preceding the merger negotiations that breached the contractual duties the limited partnership agreement imposed. The limited partnership agreement replaces common law fiduciary duties with a contractually adopted fiduciary duty of subjective good faith and deems this contractual duty to be satisfied if a committee of independent directors grants "Special Approval" to a transaction, so long as the independent directors themselves act with subjective good faith. We conclude that the plaintiff's allegations that the independent directors failed to negotiate effectively do not permit a reasonable inference that the independent directors breached their duty to act with subjective good faith, and therefore we AFFIRM the Court of Chancery's dismissal of the complaint.
I. FACTUAL AND PROCEDURAL BACKGROUND
A. The Parties
This dispute stems from the unit-for-unit exchange (the Merger) by which Vanguard
Encore's general partner is Encore Energy Partners GP LLC (Encore GP), a Delaware limited liability company. Scott W. Smith, Richard A. Robert, Douglas Pence, W. Timothy Hauss, David Baggett, John E. Jackson, and Martin G. White served on Encore GP's Board of Directors (the Encore Board) at all relevant times. Baggett, Jackson, and White are independent directors and comprised the Encore Board's Conflicts Committee. Directors Smith, Robert, Pence, and Hauss are Vanguard employees. Vanguard, Encore GP, and the Encore Board members are the Defendants in this action.
B. Vanguard Acquires an Interest in Encore and Encore Makes Pessimistic Disclosures
In late 2010, Vanguard acquired Encore GP and 46% of Encore's common units from a third party.
The Complaint alleges that other statements also justify an inference that Vanguard intentionally depressed Encore's unit price before proposing the Merger. In February 2011, Encore issued its fourth-quarter results for 2010 and provided earnings guidance for 2011 (the February Release). Although Encore's 2010 fourth-quarter earnings exceeded analysts' predictions, Encore's 2011 forecasts were downbeat. Encore predicted that 2011 oil and gas production would be lower than analysts' expectations.
The February Release also stated that Encore GP planned to triple its capital expenditures. As a result, the February Release forecast that Encore would cut distributions to its unitholders to $1.80$1.85 per unit. These projected distributions were lower than analysts' expectations and represented the lowest level of distributions since Encore's initial public offering.
Based on these actions, Allen alleges that Encore's unit price at the time Vanguard proposed the Merger reflected "negative pressure from disclosures that were inaccurate and reflected value-depressive policies adopted by Vanguard in the months leading up to the [Merger proposal]."
C. Vanguard Offers to Acquire Encore's Remaining Common Units
While Encore GP was making the allegedly value-depressing disclosures, Vanguard was planning to propose the Merger, which it had been considering since late 2010. After Vanguard acquired its interest in Encore and Encore GP, Vanguard's management continued to study the potential effects of combining the companies and discussed that possibility with Vanguard's board of directors. Vanguard's management "continued to believe that a combination" of the companies was desirable, but indicated that market conditions and Vanguard's and Encore's relative trading prices were "not conducive to completing a
On March 24, 2011, when Encore's unit price closed near a two-week low relative to Vanguard's unit price, Vanguard announced its initial Merger offer. Vanguard proposed to convert each Encore common unit into 0.72 Vanguard common units. Based on Vanguard's closing price that day, the Merger offer implied that each Encore unit was worth $23.20 — a 0.2% premium to Encore's preannouncement closing price.
D. The Encore Board Delegates Authority to its Conflicts Committee and the Conflicts Committee Negotiates with Vanguard
Because a majority of the Encore Board members were Vanguard employees and Vanguard owned Encore GP and 46% of Encore's common units, the Encore Board delegated authority to its Conflicts Committee to "study, review, evaluate, and negotiate" the proposed Merger terms, retain independent advisors, decide whether the proposal, an alternative, or neither option were advisable, and recommend the proposal to the Encore Board if appropriate. Smith had previously advised the Conflicts Committee that Vanguard might propose a merger and recommended that the Conflicts Committee consider engaging independent advisors. The Conflicts Committee selected Bracewell & Giuliani LLP and Richards, Layton & Finger, P.A., as its legal advisors, and Jefferies & Company, Inc., as its financial advisor.
Over the next several days, the Conflicts Committee members negotiated amended indemnification agreements with Encore GP and Encore after consulting with Bracewell & Giuliani. They proceeded to negotiate standstill and confidentiality agreements with Vanguard. After completing these matters, the Conflicts Committee commenced six weeks of due diligence. Allen conceded that the Conflicts Committee informed itself of relevant facts, including the allegedly value-depressive disclosures and the companies' relative unit prices.
On June 15, 2011, the Conflicts Committee responded to Vanguard's offer by proposing a 1:0.75 exchange ratio, which was 4.17% higher than Vanguard's opening offer. The Proxy Statement indicates that the Conflicts Committee members made this counteroffer because they believed Vanguard would not agree to an exchange ratio that would dilute Vanguard's distributable cash flow per unit, an important metric for master limited partnerships. During the period between Vanguard's offer and the Conflicts Committee's response, however, Vanguard units had experienced a company-specific price drop. As a result, the counteroffer now represented a 9.1% discount to Vanguard's opening offer. Vanguard countered with a
In connection with the Merger, Jefferies rendered a fairness opinion stating that the Merger's terms were financially fair.
On July 10, 2011, after reviewing Jefferies's fairness opinion and consulting with its legal advisors, the Conflicts Committee unanimously approved the Merger and recommended it to the Encore Board, which in turn approved the Merger and submitted it to the unitholders. Vanguard's trading price on the last trading day before the Encore Board approved the Merger implied a valuation of $21.94 per Encore unit, below the implied valuation in Vanguard's original offer. Based on Vanguard's pre-Merger quarterly distribution projections, Encore's unitholders would initially receive lower distributions after exchanging their units for Vanguard units than they would have received had they remained Encore unitholders.
E. Encore's Unitholders Approve the Merger and the Transaction Closes
On November 30, 2011, a majority of Encore's unitholders (including Vanguard as a 46% unitholder) approved the Merger at a special meeting. When the Merger closed on December 1, 2011, the exchange ratio implied a valuation of Encore at $20.82 per unit — again below Vanguard's original offer.
F. Procedural History
This litigation began in April 2011, shortly after Vanguard made its initial acquisition proposal. Allen and another plaintiff filed the operative Complaint on December 28, 2011, after the unitholders' special meeting that approved the Merger. The Complaint alleged that the Defendants breached their contractual duties to the class members by proposing, approving, and consummating a transaction that was unfair, unreasonable, and undertaken in bad faith. The Defendants moved to dismiss all of Allen's claims, and the Vice Chancellor granted their motion in his Memorandum Opinion.
II. STANDARD OF REVIEW
We review de novo the Vice Chancellor's decision to grant a motion to dismiss under Court of Chancery Rule 12(b)(6).
A. What Contractual Standards Apply to the Defendants?
This Opinion is the latest in a series of cases involving conflicted transactions in the master limited partnership context.
Under the DRULPA, a limited partnership agreement may "expand or restrict or eliminate" any fiduciary duties a partner or other person owes to a limited partnership, another partner, or other person, "provided that the partnership agreement may not eliminate the implied contractual covenant of good faith and fair dealing."
As the Vice Chancellor held, this provision indicates that Encore GP and each Indemnitee only owe the fiduciary duties expressed in the LPA; they do not owe
This definition encompasses the Encore Board members, who possess the power to control Encore GP by virtue of their positions. Because Vanguard controls Encore GP through its ownership interest, Vanguard also comes within the definition of "Affiliate." Therefore, Section 7.9(e) applies to all Defendants.
The LPA creates a contractual duty that replaces the common law fiduciary duties Section 7.9(e) eliminates. Section 7.9(b) requires that when Encore GP "makes a determination or takes or declines to take any other action, or any of its Affiliates causes it to do so," in its capacity as Encore's general partner, Encore GP and its Affiliates shall "make such determination or take or decline to take such other action in good faith."
Finally, Section 7.8(a) exculpates Indemnitees "for losses sustained or liabilities incurred as a result of any act or omission of an Indemnitee" unless a court enters a judgment determining that "the Indemnitee acted in bad faith or engaged in fraud, willful misconduct or, in the case of a criminal matter, acted with knowledge that the Indemnitee's conduct was criminal."
B. The LPA's Provisions Governing Conflicts of Interest
LPA Section 7.9(a) establishes four "safe harbors" that the Defendants can use to discharge their contractual duty of good faith when confronted with a conflict of interest.
The LPA defines "Special Approval" as "approval by a majority of the members of the Conflicts Committee acting in good faith."
Notwithstanding this elaborate structure, Defendants suggest that Section 7.10(b) creates a more generally applicable conclusive presumption that they acted in good faith when they rely on a fairness opinion. Section 7.10(b) provides:
This provision is substantively identical to the one we construed in Gerber v. Enterprise Products Holdings, LLC.
Allen argues that LPA Section 7.9(a)'s safe harbor creates only a rebuttable presumption of good faith when Encore resolves a conflict of interest. Therefore, he claims that Section 7.10(b)'s generally applicable conclusive presumption of good faith does not apply to conflict-of-interest transactions, which the specific safe harbor provision in Section 7.9(a) governs.
C. What is Required to Plead a Breach of the LPA's Contractual Duty of Good Faith?
To determine whether Allen has pleaded that the Defendants breached the LPA's contractual duty of good faith, we must first analyze what standard the LPA imposes. We construe limited partnership agreements in accordance with their terms in order to give effect to the parties' intent.
The LPA's contractual duty requires a "belie[f] that the determination or other action is in the best interests of the Partnership." Black's Law Dictionary defines believe as "[t]o feel certain about the truth of; to accept as true," whereas it defines reasonably believe as "[t]o believe (a given fact or combination of facts) under circumstances in which a reasonable person would believe."
The Vice Chancellor further held that Allen must show that the Defendants "subjectively believed that they were acting against Encore's interests" to plead a breach of this contractual duty.
In Lyondell Chemical Co. v. Ryan, a corporate fiduciary duty case, we reaffirmed that "intentional dereliction of duty, a conscious disregard for one's responsibilities" is a type of conduct that lies between "subjective bad faith" and "gross negligence," and that it constituted "bad faith" under Delaware corporate fiduciary law.
To fail intentionally to act in the face of a known duty, however, there must be a "duty." Here, the LPA replaced the common law fiduciary duties of loyalty and care with a contractual duty of subjective good faith. Therefore, the only duty the Conflicts Committee members had was to form a subjective belief that the Merger was in Encore's best interests. To plead a breach of the subjective good faith standard under a conscious disregard theory, Allen must show that the Conflicts Committee
We cannot accept Allen's invitation to import standards of conduct from corporate or tort law to govern the Conflicts Committee's negotiation process. The LPA explicitly provides that when the LPA requires Encore GP or its Affiliates to make a determination in "good faith," they "shall not be subject to any other or different standards imposed by [the LPA]... or under the [DRULPA] or any other law, rule or regulation or at equity."
Therefore, to plead a breach of the LPA's contractual duty of subjective good faith, Allen must plead facts that enable a court reasonably to infer that the Conflicts Committee members did not subjectively believe that the Merger was in Encore's best interests. Allen can meet this standard by showing that the Conflicts Committee believed it was acting against Encore's best interests when approving the Merger. He can also do that by showing that the Conflicts Committee consciously disregarded its duty to form a subjective belief that the Merger was in Encore's best interests.
D. Does the Complaint Plead Sufficient Facts to Permit an Inference That the Conflicts Committee Members Breached Their Contractual Duty of Subjective Good Faith?
If the Conflicts Committee members acted with subjective good faith when approving the Merger, their approval meets the LPA's definition of Special Approval and would compel a conclusion, by the operation of the LPA's plain terms, that no Defendant breached the LPA by consummating the Merger. Therefore, we next address whether the Complaint's allegations permit us to infer that the Conflicts Committee members breached their contractual duty of subjective good faith when approving the Merger. Only the Conflicts Committee members' (as opposed to all Defendants') subjective good faith is relevant to this determination.
We first must analyze how a plaintiff pleads a defendant's state of mind. We have recognized that "it may be virtually impossible for a ... plaintiff to sufficiently and adequately describe the defendant's state of mind at the pleadings stage."
Pleaded facts indicating only that a transaction's terms fell below an objective standard of reasonableness are logically relevant to analyzing whether a Defendant satisfied the LPA's subjective standard. But, they are neither necessary nor sufficient to justify a reasonable inference that the Conflicts Committee did not act with subjective good faith. Some actions may objectively be so egregiously unreasonable, however, that they "seem essentially inexplicable on any ground other than [subjective] bad faith."
It is essential to ensure, however, that the subjective good faith standard remains distinct from an objective, "reasonable person" standard. Therefore, the ultimate inquiry must focus on the subjective belief of the specific directors accused of wrongful conduct. The directors' personal knowledge and experience will be relevant to a subjective good faith determination, which must focus on measuring the directors' approval of a transaction against their knowledge of the facts and circumstances surrounding the transaction. Trial judges should avoid replacing the actual directors with hypothetical reasonable people when making the inquiry. With that in mind, we turn to the Complaint's allegations.
The Complaint alleges that Vanguard's initial offer contained a negligible premium and that the Conflicts Committee's counteroffer was only 4% higher. It further alleges that, after accounting for a company-specific drop in Vanguard's unit price, the counteroffer represented a 9.1 % discount to Vanguard's initial offer. The counteroffer fell below the median of the various metrics used in Jefferies's fairness opinion and was below the bottom of Vanguard's advisor's valuation metric and the widely used standardized measure metric.
Allen does not contend that the Conflicts Committee members were conflicted, so their independence is unquestioned. The Complaint clearly alleges that the Conflicts Committee members began the process knowing that Vanguard had refused to consider selling Encore GP or the 46% of Encore's LP units it held, effectively foreclosing an auction process. The only reasonable inference is that the Conflicts
Viewed in this context, the Conflicts Committee's counteroffer, while providing only a meager increase in the exchange ratio and a discount from the initial offer, does not justify a reasonable inference that the Conflicts Committee members breached the LPA's contractual duty of subjective good faith. Although Allen attacks the Conflicts Committee's counteroffer as "indefensible," he ignores the Proxy Statement's disclosures that the Conflicts Committee based its counteroffer on its belief that Vanguard would not agree to an exchange ratio that would dilute its distributable cash flow per unit. The Proxy Statement indicates that a 1:0.75 exchange ratio approached the point where the Merger would dilute Vanguard's distributable cash flow per unit. The Conflicts Committee also believed that Encore's unit price already reflected a premium because the market anticipated a merger with Vanguard. Allen fails to allege that these facts were "not among the bases for the Conflicts Committee members' subjective belief that the Merger was in the Partnership's best interests."
The allegations that the Conflicts Committee's counteroffer was below the median of Jefferies's analyses' ranges are similarly insufficient. Jefferies provided nine separate valuation metrics. The counteroffer fell within eight of them (and was above the remaining metric's range). While Allen argues that two alternative metrics are "industry-specific" and "widely used," he does not contend that Jefferies's valuation metrics were inappropriate. There is no allegation that the alternative metrics were so widely adopted in the industry that their absence would have been apparent to the Conflicts Committee members or that their absence rendered Jefferies's analyses fatally flawed.
The Vice Chancellor noted that the Complaint alleges that the Conflicts Committee ran a "shoddy" negotiation with Vanguard and obtained a "[m]eager" exchange ratio improvement.
Nor does Allen's Complaint allege any facts from which we can reasonably infer that the Conflicts Committee members consciously disregarded their contractual duty. To plead adequately that the Conflicts Committee members failed to act in good faith under this theory, the Complaint must allege in a nonconclusory way that the Conflicts Committee members consciously disregarded their duty to believe subjectively that the Merger was in Encore's best interests. The Conflicts Committee members' conduct is relevant only if and to the extent it shows they failed to form a subjective belief that a transaction was in Encore's best interests. Here, the Complaint alleges that the Conflicts Committee members negotiated over several months, retained independent advisors, and refused to agree to the Merger until Vanguard increased the exchange ratio. Allegations that the Conflicts Committee should have started with a higher counteroffer, should have negotiated more forcefully, and should thereby have achieved a better result do not support a reasonable inference that the Conflicts Committee consciously disregarded a duty to form a subjective belief that a transaction was in Encore's best interests. Therefore, we hold that Allen has failed to plead facts that, if true, would establish that the Conflicts Committee members breached their contractual duty to act in subjective good faith when approving the Merger.
E. What is the Effect of Special Approval on the Allegations that Vanguard Drove Down the Price of Encore's Units?
We now address the effect on Vanguard of the Conflicts Committee's valid Special Approval. Allen argues that Special Approval cannot insulate Vanguard from liability for causing Encore GP to issue allegedly value-depressing disclosures in the January and February Releases, or for increasing Encore's capital expenditures and correspondingly reducing distributions.
As the Vice Chancellor held, Allen's Complaint contains a single claim for relief — "Defendants breached their contractual duties to [Encore's unaffiliated unitholders] by proposing, approving and consummating a transaction that was not fair or reasonable and was undertaken in bad faith, and [Encore's unaffiliated unitholders] have suffered damages thereby."
Because Allen's only claim is that the Merger was unfair and undertaken in bad faith, Vanguard's allegedly value-depressing disclosures are relevant only insofar as they resulted in a unfair exchange ratio for the Merger itself. The Conflicts Committee gave Special Approval to the Merger.
For these reasons, we AFFIRM the Court of Chancery's dismissal of Allen's Complaint.
Here, the Proxy Statement is integral to the Complaint because Allen quotes from and cites the Proxy Statement almost exclusively in making his allegations regarding the Merger negotiation process and Vanguard's motivations for the transaction. See App. to Opening Br. A446-50 (relying on the Proxy Statement for its allegations); see also Orman v. Cullman, 794 A.2d 5, 16 (Del.Ch.2002) (holding that a proxy statement was "integral to [a] complaint as it [was] the source for the merger-related facts as pled in the complaint"). Having premised his factual allegations squarely on the Proxy Statement, Allen cannot fairly, even at the pleading stage, ask a court to draw inferences contradicting the Proxy Statement unless he pleads nonconclusory contradictory facts. In re Synthes, Inc. S'holder Litig., 50 A.3d 1022, 1026 (Del.Ch. 2012) (citations omitted). This case is unlike In re Santa Fe Pacific Corp. Shareholder Litigation, where the plaintiff relied upon a proxy statement for disclosure claims but not for other merger-related claims. 669 A.2d at 69-70. Here, in contrast, Allen only pleads that the Defendants breached their duties under the LPA and relies upon the Proxy Statement for substantive factual allegations. Therefore the Vice Chancellor properly considered the Proxy Statement.